Methods of Valuing Shares and Goodwill Explained with Examples
The valuation of shares and goodwill is an important part of accounting. It helps in knowing the true value of a company’s shares and its business reputation. This topic is highly relevant for CBSE Class 12, CA Foundation, and competitive exams. It is also useful for business owners and professionals to make informed financial decisions.
| Basis | Valuation of Shares | Valuation of Goodwill |
|---|---|---|
| Purpose | To determine the fair value of a company’s shares | To find the value of business reputation |
| Key Methods | Net Asset Method, Yield Method, Fair Value Method | Average Profit Method, Super Profit Method, Capitalisation Method |
| Where Shown | Under “Share Capital” in Balance Sheet | Under “Intangible Assets” in Balance Sheet |
| Who Needs | Investors, Companies, Regulators | Partners, Buyers, Sellers |
Valuation of Shares and Goodwill: Meaning and Importance
Valuation of shares and goodwill means calculating the actual worth of shares and reputation of a business. This is crucial for mergers, acquisitions, and investment decisions. It often appears as MCQs in commerce exams. At Vedantu, we simplify this concept for students and help them excel in exams.
Key Methods for Valuation of Shares
Valuation of shares is done using different methods depending on the situation. The main methods are:
- Net Asset Method – Based on assets and liabilities value.
- Yield Method – Based on expected income from shares.
- Fair Value Method – Combines both net assets and yield values.
Share valuation is crucial for investors and for reporting in company accounts. For details, see Issue of Shares and Equity Shares and Preference Shares.
Common Methods for Valuation of Goodwill
Valuation of goodwill mainly uses these MCQ-focused methods:
- Average Profit Method – Multiplies maintainable profits by number of years' purchase.
- Super Profit Method – Goodwill = Super profit × Number of years' purchase.
- Capitalisation Method – Goodwill = Capitalised value of profits minus actual capital employed.
For step-by-step help, refer to Goodwill and Capitalisation Method.
MCQs on Valuation of Shares and Goodwill
-
Which method compares fair market value with book value to estimate goodwill?
(A) Net asset method
(B) Average profit method
(C) Annuity method
(D) Capitalisation method
Answer: (D) -
The main purpose of share valuation is:
(A) Record keeping
(B) Tax calculation
(C) Evaluating product quality
(D) Forecasting future market values
Answer: (D) -
Goodwill of a company usually results in:
(A) Reduced taxes
(B) Lower earnings
(C) Higher purchase value
(D) Decreased sales
Answer: (C) -
The annuity method of goodwill valuation calculates goodwill using:
(A) Present value of super profits as an annuity
(B) Book value of assets
(C) Number of shares issued
(D) None of these
Answer: (A) -
In the capitalization method, goodwill is calculated as:
(A) Average profit × Years' purchase
(B) Actual capital employed × Rate of return
(C) Market value ÷ Book value
(D) Capitalized value of average profits – Actual capital employed
Answer: (D) -
Goodwill is recorded on a balance sheet under:
(A) Fixed assets
(B) Current assets
(C) Liabilities
(D) Intangible assets
Answer: (D) -
Average profit method for goodwill multiplies past profits by:
(A) Rate of return
(B) Market price
(C) Years' purchase
(D) Number of shares
Answer: (C) -
Super profit is calculated as:
(A) Average profit – Market profit
(B) Profit before tax – Average profit
(C) Average profit – Normal profit
(D) None of these
Answer: (C) -
According to the net asset method, share value is:
(A) Net assets ÷ Number of shares
(B) Total liabilities × Number of years
(C) Market value of shares
(D) None of these
Answer: (A) -
Which is a key factor in capital employed analysis?
(A) Fixed assets and trade receivables
(B) Only intangible assets
(C) Inventory only
(D) Debentures only
Answer: (A)
Real-World Application of Valuation of Shares and Goodwill
Companies use valuation of shares and goodwill during mergers, takeovers, or when raising new capital. Investors also need these values to make better decisions. In exams, students are often asked to solve such MCQs or calculation-based questions. See more examples in DK Goel Accountancy Solutions.
Further Reading: Related Accountancy Topics
- Goodwill: Learn about goodwill calculation and its effect on accounting.
- Superprofit Method and Capitalisation Method: Compare main goodwill valuation methods.
- Classification of Goodwill: Understand types of goodwill for exams.
- Equity Shares and Preference Shares: Know more about share types and their valuation.
- Ledger Accounts: Learn accounting entries related to shares and goodwill.
In summary, the valuation of shares and goodwill is essential for understanding the financial health of a business. It helps students prepare for board and professional exams and supports smart business decisions. Practice MCQs and study the different methods to strengthen your understanding of this important commerce topic.
FAQs on MCQs on Valuation of Shares and Goodwill for Exam Preparation
1. What is the valuation of shares and goodwill?
Valuation of shares and goodwill determines the fair market value of a company’s shares and its intangible asset, goodwill. This is crucial for accounting, investment decisions, and mergers & acquisitions.
2. Which methods are used to value goodwill?
Several methods exist for goodwill valuation. Common methods include the super profit method, average profit method, and capitalization method. The choice depends on the available data and context.
3. Where are shares shown on a balance sheet?
Shares are presented in the equity and liabilities section of a company’s balance sheet under the heading “Share Capital”. This reflects the company's ownership structure.
4. Why is the valuation of shares necessary?
Share valuation is essential for various reasons. It informs investment decisions, aids in mergers and acquisitions, establishes fair prices for buying or selling shares, and is vital for accurate financial reporting.
5. What factors affect a company’s goodwill?
Several factors influence a company's goodwill. Key factors include its strong reputation, quality of management, positive customer relations, favorable market conditions, and consistent, strong earning trends.
6. How does the capitalization method differ from the super profit method while valuing goodwill?
The capitalization method values goodwill based on the capitalized average profit or super profit, while the super profit method calculates goodwill by multiplying the excess profit by the number of purchase years. They use different approaches to arrive at a value.
7. Is goodwill amortized or impaired in modern accounting?
Under current accounting standards, goodwill is typically tested for impairment annually rather than being amortized. This reflects the ongoing nature of goodwill's value.
8. Can the valuation of shares differ for minority and majority shareholders?
Yes, the valuation of shares can differ. Minority shares often have a lower valuation than majority shares due to the lack of control, often incorporating a “minority discount”.
9. Why is goodwill considered an intangible asset?
Goodwill is classified as an intangible asset because it represents non-physical assets such as brand reputation and strong customer relationships. These assets have value but cannot be physically touched or seen.
10. Which factors affect goodwill valuation?
Goodwill valuation is influenced by various factors, including the company's profitability, market conditions, and its competitive advantage. Super profits and the capitalization method are commonly used techniques.
11. What is the main purpose of valuing shares?
The primary purpose of share valuation is to determine a fair market price. This is crucial for various corporate actions such as mergers, acquisitions, and initial public offerings (IPOs). Understanding the intrinsic value is key.
12. What does “capitalization method” mean?
The capitalization method in goodwill valuation uses a company's average profits or super profits to determine its value. It capitalizes these profits using a capitalization rate (e.g., based on market interest rates) to find the total business worth.
13. How are shares shown in the balance sheet?
Shares are listed in the equity and liabilities section of a company's balance sheet under the share capital account. It also includes information about preference shares and equity shares, reflecting the company’s financial structure.
